Insurer Owes No Duty to Settle Within Policy Limits

Our lawyers are recognized as experts in their areas of concentration and are frequently called upon to speak at seminars for the legal community, insurers, corporations, and professional associations. They also write articles of interest to our clients, the Bar, and the public, and produce newsletters to provide our clients with the latest information and developments on trends in the law and specific legal areas.

Insurer Owes No Duty to Settle Within Policy Limits

3/9/2009 The Seventh Circuit Court of Appeals recently ruled that an insurer owed no duty to settle in good faith on behalf of an uninsured policyholder in the case of Iowa Physicians' Clinic Medical Foundation v. Physicians Insurance Co. of Wisconsin, 547 F.3d 810 (7th Cir. 2008). This was an issue of first impression in Illinois. Therefore, the Seventh Circuit attempted to predict how the Illinois Supreme Court would rule if the issue was before it.

Iowa Physicians' Clinic Medical Foundation, doing business as Iowa Health Physicians ("IHP"), runs a clinic in Geneseo, Illinois. Dr. Randall Mullin worked at the clinic in Geneseo. As part of a hiring incentive, IHP purchased medical malpractice coverage from Physicians Insurance Company of Wisconsin for Dr. Mullin providing up to $1 Million in coverage. While IHP paid the premiums for the policy, it did not purchase coverage for itself. Throughout the policy it was reiterated that coverage did not extend to IHP. There was nothing preventing IHP from purchasing insurance coverage from PIC. Instead, IHP chose a combination of self-insurance and a separate commercial insurance policy. 547 F.3d at 811.

Dr. Mullin and IHP were sued by the surviving spouse and estate of one of Dr. Mullin's patients for wrongful death. Apparently, there was a very good basis for the wrongful death suit. Many experts agreed that Dr. Mullin provided substandard care to the patient. The damages in the wrongful death suit threatened to be very large since the economic damages to the widow and child alone were estimated at over half a million dollars. Also, the patient suffered severe pain before his death.

The insurance policy gave PIC control over Dr. Mullin's defense, which meant that Dr. Mullin could only settle if he received written consent from PIC. Both IHP and Dr. Mullin urged PIC to settle the case. On more than one occasion, the plaintiff offered to settle the case for $900,000, just below the policy limit. PIC simply ignored the demand. Shortly after the last settlement demand of $900,000, the defense's expert witness admitted in his deposition that Dr. Mullin's treatment deviated from the standard of care. This admission led the plaintiff to withdraw the $900,000 demand, and submit a new demand for $1.5 million. 547 F.3d at 811-812. In response to this demand, PIC offered $200,000, which the plaintiff did not deem worthy of a response.

The case was tried. The jury found both Dr. Mullin and IHP liable and awarded $3.5 million in damages. PIC paid the policy limit of $1 million and IHP, upon agreement with Dr. Mullin, paid the remaining $2.5 million. Id. at 812.h

IHP and Dr. Mullin sued PIC in state court claiming that PIC breached a duty owed to both of them to settle the claim in good faith. PIC removed the case to federal court. Once the case was removed, PIC filed a motion for judgment on the pleadings. PIC argued that the duty to settle in good faith only extended to Dr. Mullin, who was an insured under the policy, and not to IHP, which was excluded from coverage under the policy. As for Dr. Mullin, PIC argued that he suffered no damages since IHP paid the judgment in excess of the policy limit. The magistrate judge ruled in favor of PIC as to IHP, finding that PIC owed IHP no duty. IHP's claim was dismissed. The magistrate entered a final judgment as to IHP so that the decision could be appealed immediately. Id.

A duty-to-settle case usually involves three parties: the injured party; the insured; and the insurer. The insurer controls the defense and indemnifies the insured. If the injured party sues for an amount above the stated policy limit, and seeks a settlement close to the policy limit, then a conflict of interest arises between the insurer and the insured. "[T]he insurer may be tempted to decline the settlement offer, no matter how good the deal is for the insured, and go to trial. It makes no difference to the insurer's bottom line whether the case is settled or the jury awards astronomical damages; in either event it will pay out only the maximum on the policy." The insured does not view trial in the same manner because the insured would be responsible for paying any amount in excess of the policy limit. This is where the conflict arises. The duty to act in good faith in responding to settlement demands has been recognized as a way to be sure that the intent behind the insurance contract is upheld. If the insurer breaches the duty to act in good faith in responding to settlement demands, then the insured is not responsible for paying any amount awarded over the policy limit. The breach of this duty is commonly referred to as a bad faith claim. If it is determined that the insurer acted in bad faith, the insurer is responsible for paying the entire judgment regardless of the policy limit. 547 F.3d at 812, citing Cramer v. Ins. Exch. Agency, 174 Ill.2d 513, 675 N.E.2d 897, 903, 221 Ill.Dec. 473 (1996).

In this case, there were actually four parties to the duty-to settle case: the injured party (plaintiff), insured (Dr. Mullin), the insurer (PIC), and the policyholder (IHP). By claiming that PIC owed it a duty of good faith in responding to the settlement demand, IHP was really asking the court to expand the duty to settle to cover the policyholder. The Seventh Circuit rejected this proposed expansion of the duty.

IHP argued that the duty should apply because of the contractual relationship between it and PIC. "The duty to settle is designed to protect the bargain embodied in an insurance contract ... Id at 813. This duty has nothing to do with honoring the relationship between the parties to the contract. IHP and PIC contracted to provide coverage to Dr. Mullin only. Therefore, the benefits of the contract inured only to Dr. Mullin. As an insured, Dr. Mullin had a right to expect PIC to act in good faith in responding to settlement demands. Since IHP chose not to purchase coverage for itself, it could not have the same expectation. "The duty to settle is meant to protect the bargained-for insurance coverage, not extend it."

The Court also pointed out that the duty to settle is necessary because of the insurer's exclusive control over the defense of the case and settlement negotiations. In this case, IHP was a co-defendant in the case. IHP was represented by counsel throughout the time the case was litigated. PIC exercised no control over IHP's defense and did not prevent IHP from negotiating a settlement with plaintiff. IHP argued that it should not have been expected to pay anything toward settlement because of the Illinois Supreme Court's recognition that "a principal who is vicariously liable for its agent's negligence is 'blameless.'" 547 F.3d at 814, quoting American Nat'l Bank & Trust Co. v. Columbus-Cuneo-Cabrini Med. Center, 154 Ill.2d 347, 609 N.E.2d 285, 289, 181 Ill.Dec. 917 (1992). Blame and liability are not synonymous. IHP was found to owe a legal duty to the plaintiff in the underlying case, a duty the fact-finder determined that it breached.

In affirming the district court's dismissal of IHP's claim for breach of the duty to settle, the Seventh Circuit suggested that IHP should consider pursing a contribution or indemnification claim against Dr. Mullin to mitigate its injury. There was nothing about this case to require an expansion of the duty to settle to cover policyholders who choose to purchase coverage only for a third party. Maybe the Illinois Supreme Court will have an opportunity to visit this issue in the future. It would be interesting to find out if the Illinois Supreme Court agrees with the reasoning of the district court and the Seventh Circuit.